Yesterday the Fifth Circuit reversed the class certification in the Enron shareholder suit pending in Judge Melinda Harmon's court in the Southern District of Houston. The trial was scheduled to begin in April. Similar to the 2nd Circuit's reversal of class certification in the IPO Cases, the panel seems to get into the merits of the cases. Here, according to the Houston Chronicle, the Fifth Circuit reversed because the defendants remaining, the banks, were not primary violators but mere aiders and abettors. (Readers will recall that for strategic purposes, the plaintiffs dropped many of the individual Enron defendants who would have been primary violators under the theory of the case.)

So, not to make everything about ME, but If this were going to happen, it could have happened before I sent out my paper, The Undercivilization of Corporate Law, which compares criminal prosecutions to civil lawsuits under the same set of facts suggesting corporate misconduct. So, here we have a set of facts that spawned the Enron Task Force, which gathered numerous guilty pleas and even criminal convictions, some of which have been reversed by appellate courts. However, under the same set of facts, shareholders are not able to overcome procedural obstacles (or inherent collective action problems) to succeed in a civil lawsuit. (The Enron plaintiffs were able to secure record-setting settlements from other banks, who may feel silly today, but I'm not sure if those settlements have been approved yet. That's an item for additional research today.)

Christine, this is the case against banks, and the criminal case was against corporate insiders. The two most certainly do not involve "the same set of facts," as you suggest.

Furthermore, the reversal of the class certification in federal court does not mean defendant banks are off the hook. Plaintiffs will simply put together groups of less than 50 big plaintiffs and sue in state courts under exactly the same theories. This is happening in other class actions that ended up in state courts after PSLRA (e.g., the one against AOL).

Generally, I think your "under-civilization" claim is vastly overblown, both normatively and positively. We’ve had many years of experience with civil litigation of corporate wrongdoings, and the empirics on its effectiveness are not encouraging.

Professor Litvak, you apparently neglect to include in your thinking the criminal cases against the former Merrill Lynch executives and against Arthur Andersen, which though styled as an obstruction case was a story told using “the same set of facts” suggesting that Enron and its so-called “enablers” were criminal.

In any event, Professor Hurt's important observation that the tolerance of Type 1 errors in criminal cases and civil cases have been turned on its head in recent years is not “vastly overblown.” If anything she is much too constrained. Now, whether revitalizing the civil arena is the right way to go is another question.

The empirics of the effect of civil litigation on corporate wrongdoing, to my knowledge are quite encouraging. At least the cross-country studies show that nations that allow private enforcement of securities fraud laws have vastly more robust stock markets than those that do not.

Frank is referring to a single finance paper, which found, in cross-section, that higher quality of securities laws is correlated with more developed markets. This surely is not enough to be “quite encouraging” about the value of civil securities litigation. First, LLS don’t deal with reverse causation, and don’t even claim to deal with reverse causation. It’s possible and likely that countries with more developed securities markets (which correlate with higher gdp per capita and other proxies for the development of the economy) proceeded to create more stringent securities laws, not the other way around. Second, LLS do not study actual enforcement, only laws on the books, which may systematically overvalue certain types of securities regimes (i.e., English common law). Third, they do not have anything to say about the marginal effect of the jump from, say, 100 cases per year to 1000, because most countries in the world very, very few cases every year. It’s possible and likely that a small number of cases is sufficient for deterrence, so 10 cases per year may yield net positive results on the margin, but 100 cases per year may yield net negative results. And yet, the issue for the US is not the difference between 0 and 10, but the difference between several dozen and several hundred. LLS say nothing on this matter. Fourth, LLS say nothing about the value of securities class actions – again, because most countries in the world don’t have securities class actions. And yet, it’s class actions that actually matter in the US.

When we look at the more relevant research – not cross-country cross-sectional, but US-based and across time, we find very little evidence that securities class actions (the most important part of civil litigation on corporate wrongdoings) do any good. We have pretty good evidence that merits didn’t matter much pre-PSLRA. Merits seem to matter more after PSLRA, but there is still no evidence that these suits are now at the optimal level. I don’t know any respectable securities law scholar who wouldn’t think that the measure of damages in securities class actions is absurd, which undoubtedly impacts the relationship between litigation and deterrence. Finally, I am not aware of any evidence of deterrence that would give me comfort that the system where shareholders pay huge sums to lawyers while suing themselves is a net positive.

But a bigger problem with Christine’s paper is that the comparison between civil and criminal cases is simply irrelevant. Whether the procedural rules are optimal is a question that has to be based on considerations of a particular ligitable problem, not on whether these rules are sufficiently similar to the rules used in some other problem. So, for securities class actions, the relevant considerations are: (1) the need to incentivize decisionmakers whose personal wallet is usually unaffected by litigation; (2) the need to avoid frivolous law suits led by attorneys whose interests are not well aligned with those of shareholders whom they represent; and (3) the need to make procedural rules work well in the context of the entire system, i.e., together with damages rules, attorney compensation, availability of D&O insurance and indemnification, and so forth. Taking a few rules out of context and comparing them to a few other rules taken out of context illuminates nothing. If we believe that securities class actions are (1) likely to be a net negative for shareholders participating in litigation, and (2) likely to create a trivial deterrence for corporate managers in the future; and if we also believe that (3) the best deterrence for managers is the threat of criminal prosecution, then, it’s perfectly reasonable to have a system where procedural bars to civil litigation are substantially higher than those for criminal prosecution (assuming the latter are not unconstitutionally low). Likewise, if we believe that compensation incentives make it substantially more likely that Milberg Weiss brings a frivolous case than a criminal prosecutor brings a frivolous case, then it’s perfectly reasonable to have a system with higher bars on the former than on the latter (again, assuming basic constitutional protections for criminal defendants).

One cannot conclude that we are facing “undercivilization” of corporate law simply because the barriers to civil litigation might be higher than barriers to criminal prosecution. Civil barriers might be higher than criminal, while still being too low, as compared to the optimal barriers determined by the system of civil securities litigation taken as a whole. Since Christine produced no new evidence about the gap between the actual and the optimal barriers to securities litigation, I see no support at all for her claim that corporate law is “undercivilized.”